European smaller companies alters its stance as investors become more interested in beta
M&G European Smaller Companies fund manager Giles Worthington is looking to increase the £75m fund's beta in order to benefit from any improvement in market conditions.
An uptick in investors' appetite for beta has underpinned the European smaller companies sector's strong recent performance.
After a difficult three years that have seen portfolios halve in size on average, the sector has been the best performing regional asset class over the three months to 9 June, returning 23.8% on average before charges.
Worthington's portfolio has posted growth of 23% over the same period and while the fund remains cautiously positioned in the main, he believes opportunities are emerging on a stock-specific basis.
'At the margins we are looking at stocks more geared into the recovery. Small caps are on average cheap, but only if they are going to be around in three years time and that is a big if,' Worthington said.
Stocks trading at distressed levels largely drove the recent rally in European small caps, Worthington noted. Many of these failed to pass his strong balance sheet and cashflow generation requirements, leading the fund to marginally underperform its peer group over the last three months.
'Post-Iraq war, the stocks that have bounced strongly have mostly been very balance sheet distressed companies as investors took the view they were now less likely to go bust. It is a very risky area to play and does not suit my long-term investment strategy.
'Sentiment has changed, but there is little evidence the economy has done so and I would rather miss out on the occasional strong bounce than chase performance from bombed-out stocks, some of which will go bankrupt,' he said.
Although he is not overly confident on the market's direction in the short to medium-term, Worthington is finding a number of attractively valued special situations, the returns from which should provide an extra kicker should the market rally prove sustainable.
Worthington has bought into Hugo Boss on what he deems near-distressed levels, on a P/E of 8 times and 10% yield. The company disastrously launched into the women's wear market two years ago and fell out of favour with institutions after sales slumped and fraudulent accounting was discovered in its US operation.
'It is a cheap company, cashflow is still solid and the dividend is very much underpinned. It has made mistakes, but there has been no impairment of brand and at this rating you are getting the women's wear business for free. If the market goes north and they get the women's wear right, Hugo Boss should be a major beneficiary,' he added.
Other higher beta sectors Worthington has bought into include recruitment agencies. Strong non-pharmaceuticals payroll numbers in the US stirred an awakening of interest in the sector, which is regarded a classic cyclical play. He has added a couple of temporary employment agencies to the portfolio and when the market picks up these stocks would be expected to benefit from any commensurate job creation.
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